Background
Case study
Facts
Supreme Court decision
Comment
Certain guidelines and standards have been a particular focus for the Argentine tax authorities and courts when challenging third-party financing, and consequently result in negative tax consequences for the contested borrowers. Third-party financing has been challenged due to, among other things:
- a lack of standard loan documentation (necessary for the obligation to become effective against third parties under Argentine law) and evidence of an actual transfer of funds;
- an absence of a specific repayment schedule;
- the lack of a reasonable relationship between the amount lent and the borrower's net worth;
- the lender's subjective expectation regarding the loan (eg, repayment, assumption of risks, permanency of the funds);
- the lack of standard auditing procedures to assess the borrower's business risk and repayment ability; and
- the lack of guarantees to secure repayment (eg, liens on real property and other business assets, pledges of stock or other intangibles, or even personal guarantees).
As a result, a number of lending transactions have been deemed not to be genuine, leading to the disallowance of the borrower's deductions on account of interest, foreign exchange losses and other expenses related to the financing. In several cases the tainted principal amount was recharacterised as an unjustified taxable increase in net worth of the domestic borrower and, as such, treated as additionally taxable at a 35% rate in the borrower's hands.
In In re Autolatina (a case concerning a joint Argentine venture between Ford Motor Company and Volkswagen AG), the tax authorities challenged a $10 million loan allegedly granted by Deutsche Bank AG, New York, and guaranteed by a cash deposit maintained by Ford Argentina with the lender. The tax authorities denied the deductions taken by the borrower related to the loan and applied the unjustified increase to the net worth figure. As a result, the loan proceeds, subject to certain adjustments, were treated as undeclared income of the borrower. In addition, the tax authorities claimed that the non-documented expenses rule applied, under which the amount of payments made without sufficient evidence and the identification of the beneficiary are subject to income tax at the hands of the payor.
After the subsequent required judicial steps (resolution by the Federal Tax Court and the Court of Appeals), the case was finally decided by the Argentine Supreme Court of Justice on March 15 2011.
The taxpayer alleged the existence of two deposits in favour of Deutsche Bank, each for an amount that was higher than the amount of the loan challenged by the tax authorities. The taxpayer further argued that two distinct financing transactions existed:
- an investment placed with the US bank; and
- a loan received from the same bank.
The taxpayer asserted that it held a 'participation certificate' in a $10 million participation loan in which the Deutsche Bank acted as lead bank and, in addition, that it was the borrower of a loan granted for the same amount by the same bank. As proof, the taxpayer offered the testimony of its external auditors, who informed the court that they had received a telex issued by Deutsche Bank informing that it held a credit against the taxpayer, but that at the same time the taxpayer held a participation in a loan for the same amount.
In addition, the taxpayer filed a copy of a document issued several years after the date of the tainted financing transaction, in which the Argentine branch of the bank had expressed that there was a 'participation certificate' issued between the taxpayer and the bank under which the former held a participation in a loan of $10 million. This document evidenced that neither Deutsche Bank AG nor any of its agencies or branches guaranteed the existence, validity, sufficiency or collectability of the loan. The document further stated that the sole obligation and liability of the bank under the participation certificate was to settle accounts and report any redemption of principal and payment of interest from which the bank would withhold less than 2% to pay its fees.
The Supreme Court of Justice confirmed the decision of the Federal Court of Appeals, and consequently ratified the decision of the Federal Tax Court which upheld the tax authorities' position.
The Supreme Court confirmed that the taxpayer did not prove a genuine loan consistent with the criteria set forth in the National Civil and Commercial Code, and sustained that the written evidence showed that Deutsche Bank acted merely as an intermediary and did not undertake a lender-type credit risk. The Supreme Court also considered that although the taxpayer asserted that it had proved remittance and receipt of the funds, the sender of the funds was not duly identified. Therefore, in addition to confirming the tax authorities' challenge of interest and foreign exchange loss deductions, it considered that the amount of the loan was an unjustified increase in net worth, taxable to the borrower at the 35% statutory corporate tax rate.
Finally, the court sustained that the bank was not the effective beneficiary of interest paid under the loan. It therefore applied the non-documented expenses rule, pursuant to which expenses without sufficient evidence and identification of the beneficiary are subject to income tax at the hands of the payor.
The decision in this case demonstrates the actions not to be taken when entering into a pretended genuine financial transaction. The tax consequences confirmed by the Supreme Court are devastating to the Argentine payor. The application of the unjustified increase in net worth and the undocumented expense figures, coupled with the denial of foreign exchange loss and interest deductions, meant that the borrower was not only barred from taking the deductions, but also taxed on the amount of the loan and the interest payments. These consequences are even tougher when it is considered that interest payments were actually subject to withholding; the worst-case scenario may indeed occur. Although it is true that under current exchange control and banking regulations some of the facts of the case could possibly not have occurred, the conclusions of the case are still significant.
In addition, although the concept of beneficial ownership was not directly discussed in the case, some of the conclusions arrived at might be used to understand the scope of that term in a treaty context, when an intermediate entity is deemed to exist. As a result, the economic substance of the beneficiaries in a financial transaction can be considered when determining entitlement to treaty benefits. If the existence of economic substance is duly evidenced (eg, by making an arm's-length profit or bearing the risks of the borrower's default), the beneficiary should be recognised as a lender and beneficial owner of interest under tax treaties.
For further information on this topic please contact Guillermo O Teijeiro or Ana Lucía Ferreyra at Negri & Teijeiro Abogados by telephone (+54 11 5556 8000), fax (+54 11 4328 5628) or email ([email protected] or [email protected]).